Having money in the bank that you can use at any time provides some security. Although the S&P 500 may drop 20% during a market correction, your money will retain its normal value. However, that sense of security comes at a cost. The real value of your money will slowly decrease over time due to inflation.
The $100 bill was worth more in 1980 than it is today, and the same can be said for comparing current and 2010 prices. While it’s important to save something affordable, it’s also important to invest your money to grow.
Why retirees take money
Retirees tend to pull cash because there is no volatility in this asset. It’s much safer than putting your money in the stock market and wondering what the balance will be in three years. Some retirees crave predictable results more than younger investors because these people often have to withdraw from nest eggs instead of building their income with a steady payout. And they don’t have a long time horizon for their balance sheets to bounce back from a market downturn.
Older investors also remember major downturns, such as the dot-com bubble of the late 1990s and early 2000s, and the Great Recession from 2007 to 2009. Many young investors did not have to invest in those economic conditions, which made them more comfortable with taking risks. While it’s a good part of any retirement plan to have some cash to cover expenses, this benefit becomes a problem if you choose to save more money.
The hidden costs of holding too much money
A balance of $100,000 will always be a balance of $100,000 if you do not add or subtract to it. You can even earn interest on your money without taking any risk. However, annual percentage yields (APYs) on traditional savings accounts don’t tend to outpace inflation, especially considering that interest is considered ordinary income for tax purposes.
The $100,000 you saved may not buy as many products and services in the next five to ten years as it can afford right now. Not only does cash lose less purchasing power, but keeping cash on the side means you risk missing out on long-term investment growth.
It is still important for retirees to invest over time because retirement can take many decades. Some people retire at 60 and live into their 90s. Investing is one of the few ways to beat inflation and give yourself more financial flexibility deep into your retirement years.
How to balance security and growth
Wealth preservation becomes more important in retirement, but if you only play it safe, your money will lose a little purchasing power due to inflation. The bucket strategy uses basic math to create a balance between these goals. It includes setting aside money for short-term expenses, medium-term savings investments and long-term growth investments.
The exact amount of money you should keep in each bucket will depend on your goals, risk tolerance and time horizon. But here is a general guideline. The first part of the bucket strategy is to have enough spare cash to cover one to two years of living expenses. After that, you can invest the second bucket in savings vehicles in the same way as bonds for three to ten years of your retirement. The last bucket can be invested in stocks so your money can grow beyond that.
